Electromed, Inc. Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended March 31, 2018. The request metadata identifies “2017 Q3,” but the filing is for fiscal 2018 third quarter and was filed May 8, 2018. Results are unaudited and should be read with the fiscal 2017 Form 10-K.
Business context
Electromed develops, manufactures and markets airway-clearance products using High Frequency Chest Wall Oscillation therapy, principally the SmartVest Airway Clearance System. Products are sold in U.S. home-care and institutional markets and internationally through direct sales and distributors. SmartVest Connect wireless technology was launched in June 2017 and expanded to targeted adult pulmonary clinics in November 2017.
Key financial metrics
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net revenue | $7.091 million, up 6.3% | $20.457 million, up 10.1% |
| Gross profit | $5.599 million; 79.0% margin | $16.123 million; 78.8% margin |
| Operating income | $485,000; 6.8% margin | $1.418 million; 6.9% margin |
| Net income | $313,000; 4.4% margin | $783,000; 3.8% margin |
| Diluted earnings per share | $0.04 | $0.09 |
| Net cash from operations | Not provided for the quarter | $1.872 million |
- Home-care revenue increased 6.4% in the quarter and 13.4% year to date, driven by higher average selling prices and, year to date, more approvals.
- Institutional revenue increased 15.8% in the quarter but declined 19.3% year to date.
- International revenue declined 22.6% in the quarter and 20.7% year to date to $386,000.
- SG&A increased 20.9% in the quarter and 21.3% year to date, primarily from additional personnel, compensation, share-based awards, professional fees, recruiting and travel.
- Research and development expense declined to $43,000 in the quarter and $170,000 year to date.
- Net income declined 51.7% in the quarter and 39.0% year to date versus the prior comparable periods.
Cash flow, balance sheet, debt and liquidity
- Cash was $7.063 million at March 31, 2018, compared with $5.574 million at June 30, 2017.
- Working capital was approximately $16.174 million. Total current assets were $19.920 million versus current liabilities of $3.747 million.
- Operating cash flow was $1.872 million, compared with $806,000 in the prior-year nine-month period. Investing cash use was $407,000, primarily capital expenditures of $379,000. Financing activities provided $24,000.
- The company had approximately $1.116 million of term-loan principal outstanding, net of approximately $3,000 of unamortized debt issuance costs. The term loan bears interest at 3.88%, requires monthly payments of approximately $7,900 and has a final payment of approximately $1.085 million due December 18, 2018.
- The $2.5 million revolving credit line had no outstanding balance and was fully available at March 31, 2018. It expires December 18, 2018 if not renewed and is secured by substantially all tangible and intangible assets.
- Management believes cash, working capital and available borrowings will provide adequate liquidity for the next year. The company was in compliance with its debt covenants, including a minimum tangible net worth requirement of $10.125 million.
Material changes, outlook and unusual items
- Profitability weakened despite revenue growth because SG&A rose substantially faster than revenue. Gross margin remained strong but declined in the quarter from 79.7% to 79.0%; the year-to-date margin increased from 78.4% to 78.8%.
- The nine-month 2017 comparison benefited from a prior-year $212,000 retroactive Medicaid repayment; management characterized that event as nonrecurring.
- The Tax Cuts and Jobs Act produced a net approximately $160,000 tax expense from remeasurement of deferred tax balances and contributed to a 44.4% nine-month effective tax rate. A $27,000 research-and-development tax-credit benefit partially offset this impact.
- Management expects research and development spending as a percentage of revenue to remain consistent through the remainder of fiscal 2018. No specific revenue or earnings guidance was provided.
- Warranty liability increased to $680,000 from $640,000 at June 30, 2017. The company provides lifetime U.S. patient warranties and three-year warranties for institutional and non-U.S. individual sales.
- The company is evaluating adoption of the revenue-recognition standard ASC 606 and had not yet determined the adoption method or potential financial statement impact. It expects to complete the evaluation by June 30, 2018.
- There were no off-balance-sheet arrangements and no disclosed material litigation. Management stated that disclosure controls were effective and that no material changes occurred in internal control over financial reporting.
Principal risks and contingencies
- Reimbursement changes involving Medicare, Medicaid or private insurers could affect demand and revenue.
- Renewal of the revolving credit line and the ability to repay or refinance the approximately $1.085 million balloon payment due in December 2018 are important liquidity considerations.
- Debt covenant violations could permit acceleration of borrowings, restrict access to funds or prevent renewal; debt is secured by company assets and real property.
- Other risks include competition, regulatory compliance and approvals, intellectual-property protection, international distributor timing, medical-device industry changes and general economic conditions.
Investor verification checklist
- Verify the pace and sustainability of home-care growth, including referral and approval trends and average selling prices.
- Assess whether SG&A growth moderates and whether operating margins recover.
- Monitor institutional and international revenue declines and distributor purchase timing.
- Confirm repayment, refinancing or renewal plans for the December 2018 term-loan maturity and revolving credit facility.
- Review the final ASC 606 adoption decision and any resulting revenue or retained-earnings impact.
- Separate the recurring tax rate from the one-time Tax Act remeasurement expense when comparing future earnings.